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Lloyds Banking Group PLC’s 3 Biggest Weaknesses

Lloyds (LSE: LLOY) has been hitting the headlines of late after the government announced that part of its stake in the bank will be sold to the public. Encouragingly, shares will be priced at 5% below their market price and for investors holding them for more than a year, a bonus share will be awarded for every ten shares held.

Therefore, it seems to be a highly appealing offer. The problem, though, is that while Lloyds has made considerable progress since the dark days of the credit crunch, it is not yet performing as well as it perhaps should be. For example, its share price performance has been hugely disappointing in 2015, with them falling by 1%.

A key reason for this is the rather disappointing near-term prospects for Lloyds’ profitability. Certainly, it has done a sterling job of turning a major loss just a few years ago into a profit, but with growth in its net profit of 5% this year and a fall in its earnings of 6% next year being forecast, it does not appear to be making the progress which was anticipated by investors. That’s especially evident when a number of its established banking peers are set to deliver double-digit growth in 2015 and 2016 which could have a positive impact on investor sentiment.

Furthermore, the UK banking scene is rather different today than it was during the credit crunch. Notably, there are a number of challenger banks which hold huge appeal for investors since they are able to rapidly grow their market share and are also not viewed by a number of potential customers as being part of the banking scene which apparently contributed to the credit crunch. As such, it could be argued that there are better places to invest than Lloyds within the banking space – especially since a low interest rate environment looks set to stay, which is likely to keep demand for loans buoyant.

In addition, Lloyds still has a relatively low payout ratio. For example, in the current year it is due to pay out only 30% of profit as a dividend which, given its improving capital ratios and financial standing, seems rather low. This means that Lloyds presently yields just 3.3%, which is around 20% lower than the yield on the FTSE 100. As such, it could be argued that income-seeking investors should look elsewhere right now for their dividends.

Despite the above three weaknesses, Lloyds remains a high quality bank which is very likely to deliver excellent capital gains in the long run. Certainly, its forecasts for 2015 and 2016 are relatively disappointing, but it has become extremely efficient in recent years and following various asset disposals now seems to be in a strong position to post above average earnings growth over the medium to long term.

Furthermore, Lloyds is due to rapidly increase its payout ratio to as much as two-thirds of profit, and so it is very likely to become a hugely worthwhile income stock in 2016 and beyond. And, while challenger banks do have appeal, Lloyds trades on a price to earnings (P/E) ratio of just 8.8, which is among the lowest ratings in the FTSE 100. Therefore, Lloyds looks like a superb buy at the present time.

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Peter Stephens owns shares of Lloyds Banking Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.